Reverse Auction Bidding Can Bite Back

BY STEPHEN P. GENNETT

President and CEO, Carolinas AGC (Associated General Contractors)

As the nation's largest commercial construction trade association, the Associated General Contractors has long supported the concept of full and open competition. Such competition among general contractors, specialty contractors, suppliers and service providers not only energizes and improves the construction industry, it also benefits taxpayers and the nation as a whole.

Recently, a bidding process designed for the manufacturing industry has been suggested as beneficial for the construction industry. Reverse online auction bidding allows competing contractors to look at one another's bids and continually underbid the competition. Carolinas AGC has concerns about such a process ultimately hurting the quality of construction projects across North and South Carolina.

Peeking at competitors' prices

In a reverse online auction, invited contractors and/or subcontractors are given a password to a dedicated Web site created to handle the scheduled auction. At the appointed time, competing contractors log on and list their prices. If a competitor has already placed a lower bid, participants can either back out of the auction altogether or place an even lower bid.

The auctions generally allow competing companies time – often just minutes -- after each bid to counter with a lower price. After a period of no bidding activity, such as 5 minutes, the auction is closed and the lowest bid becomes binding.

This concept can indeed work fairly well for manufactured commodity items and can offer a cost savings. However, AGC believes that reverse auctions are of highly questionable benefit when applied to construction.

E-commerce, through the Internet and other means, unquestionably offers the promise of increasing competition, enabling private and public owners to reach a wider group of potential bidders and to improve the “speed to market” of projects. National AGC and the Carolinas AGC chapter encourage the use of e-commerce to enhance productivity, encouraging competition on all relevant “fronts,” including price, schedule, safety, quality, responsiveness and past performance.

Reverse online auction bidding, however, can be a misguided application of such technology, and offer false promise of lower costs. As this alternative is beginning to be considered, essentially treating construction as a commodity, owners and construction team members will face significant issues.

Reverse Auctions do not guarantee lowest price.

Reverse auction processes not only don't ensure best prices—they actually provide an incentive for bidders not to submit their lowest number. A bidder knows his or her lowest price going in, but has no motivation to offer it up front. Subsequently, he or she may never be pushed to ever offer that lowest price, and the owner would not receive what could have been a significantly lower bid had it been solicited differently.

Example: Bidder A is willing to accept $750,000 for his piece of a contract. He enters the bidding at $1,000,000, though, because he can always lower his price on the fly. Other bidders submit their numbers, and Bidder A comes in below them at $800,000. No other bid is logged within the specified period, and the $800,000 bid holds. The owner is now paying $50,000 that he likely would not have had to pay under a different bidding procedure.

A related exposure for owners is that reverse auctions create an environment in which bid discipline is critical yet difficult to maintain. Competitors have to deal with multiple rounds of bidding in quick succession, often too quickly to accurately reassess their costs or the way they would actually do the work.

Sealed bidding assures that the successful bidder is responsive and responsible.

Sealed bidding ensures that competitors have only one opportunity to price the work, encouraging each bidder to present his or her best price. For this reason, even when the owner wants to emphasize price alone, AGC believes that sealed bidding, which encourages intense price competition, will continue to serve the owner better than reverse auctioning.

In this process, each bid is evaluated against objective criteria reflecting the owner's articulated requirements and the responsibility of the bidder, ensuring fairness and value for the owner.

However, the pressure and pace of the reverse auction environment removes any assurance that initial and/or subsequent bids are responsive and material to the owner's articulated requirements. These auctions expose owners to the real possibility that they may award contracts to what would otherwise be non-responsive bidders.

Reverse auctions do not allow thorough evaluation of value.

Where price is not the sole determinant, owners increasingly have focused on negotiation to expand communication with prospective contractors. In addition to allowing discussion of criteria such as costs, past performance and unique needs, these processes recognize the value of project relationships and other factors that promote greater collaboration among the owner and project team members. Negotiation processes also consider quality, system performance, time to complete and overall value that can, in fact, outweigh the lowest price to arrive at the best value for the owner.

Reverse auctions do not promote communication between the parties. Non-price factors that are of consequence to the owner, such as quality of relationship, past performance, and unique needs, are de-emphasized in the auction. In fact, current studies of reverse auctions between buyers and suppliers have found that reverse auctions often have a deleterious effect on the relationship between buyer and seller.

Reverse Auctions for construction ignore its very nature.

Software vendors and internet service providers who host reverse auctions typically have designed their processes for the procurement of commodities and other manufactured goods.

In contrast, contractors and suppliers do not “manufacture” buildings, highways, or other facilities. Rather, they provide a mix of services, materials and systems.

Manufactured goods are subject to little or no variability or change in manufacture or application. Construction projects, on the other hand, are each subject to unique demands, such as the needs, requirements, personnel and budgetary criteria of the owner, site conditions, design features and parameters, and composition of the project team. In fact, federal procurement laws specifically recognize that construction stands apart from commodities or manufactured goods. By its nature, reverse auction bidding cannot accommodate this distinction.

On top of the above issues, there is even some question about whether reverse auctions may actually contravene federal procurement laws, which reflect a clear policy of not disclosing contractor price information.

The Carolinas AGC Board of Directors, representing more than 3,100 firms in North and South Carolina, discourages the use of reverse auction bidding.